Sunak’s time bomb
The Chancellor is right to spend money now – but there will be painful consequences Roger Bootle
Last week the Chancellor had his spending boots on. While the response to his raft of measures was generally very positive, there were two quite different critiques. One was to criticise him for not giving away enough and for time-limiting key elements, thereby setting up the possibility of a cliff edge for the economy when these concessions end.
The second line of criticism concerned the usual anxiety about where all the money is coming from. We will get a clearer perspective tomorrow, when the Office for Budget Responsibility (OBR) delivers its Fiscal Sustainability Report.
Those who complain about the inadequacy of the Chancellor’s package must be living on another planet. It cost £30bn, amounting to 1.4pc of GDP. Coming on top of earlier relief measures costing about 7pc of GDP, this means that, proportionately, the UK is giving a larger amount of fiscal support than Germany and Japan, and about the same as America. Combined with the effects of economic weakness, it will take this year’s government budget deficit to almost 20pc of GDP.
For the UK, this is by some distance the highest peacetime borrowing ever. It is not far off the total debt of 26.8pc of GDP recorded in 2001 and 2002. In one year! It will take the debt ratio to about 105pc of GDP. What’s more, the Chancellor made it clear that in the Budget and Spending Review, due later this year, there would be more investment in public services, infrastructure and the regions. So far, austerity hasn’t had a look in.
Should we be worried? Economics is a tricky subject. It is not conceptually difficult but it involves a web of conflicting relationships and conflicting values. Things are never completely straightforward. Accordingly, economic policy demands the exercise of judgment.
Is it right for the Chancellor to be dishing out so much money, causing borrowing to skyrocket? I think the answer is yes. Will there potentially be painful consequences from such largesse? I think the answer is also yes. That is why, even in this Alice in
Wonderland world where money gets squirted around like champagne at a Formula 1 celebration, the Chancellor still has to try to get the best value for what he spends. It is only in the fairy-tale world believed in by some adherents of Modern Monetary Theory (MMT) that he can spend without fear of the consequences.
And it is also why introducing time limits for his various support measures is a good idea. For a start, this maximises the chance of a relatively large effect in the near term as people bring forward activity into the coming months. It also means that the scale of the fiscal support for the economy is due to fall back later, when, it is hoped, the economy should be stronger.
This also supports the targeted nature of the measures, with money going to the sectors hardest hit, including the hospitality industry and the housing market. But this too involves a balancing act. On the one hand, the overall economy will probably be stronger the more that devastated areas of economic activity are preserved.
On the other hand, the Government shouldn’t be in the business of picking winners – and that includes picking survivors. The forces unleashed by this pandemic will probably have a lasting effect on the structure of the economy and it is important for future productivity and prosperity that the new structure, which cannot be exactly foreseen by anybody, has a chance to unfold of its own accord. This argues against trying to preserve in aspic the economic structure that existed before.
So what will the OBR say this week? Is the high debt ratio sustainable? I am pretty sure that the answer it gives will amount to “yes … but”. Although much increased debt is unwelcome, it is not, in itself, disastrous. Countries have sometimes operated successfully with even higher debt – including ourselves for much of the last 200 years.
Moreover, the current cost of financing this debt is extremely low. Ten-year gilt yields are only 0.16pc. Meanwhile, on the debt that is bought by the Bank of England, the cost is even lower. It is Bank Rate, currently 0.1pc, which is paid to the commercial banks on their deposit holdings at the Bank that finance its holding of gilts, accumulated through the policy of quantitative easing (QE). And it is likely that market interest rates will stay pretty low for some considerable period.
The “but” derives from the risk that things will not remain this accommodating – as they surely won’t forever. Suppose that market interest rates rise significantly. OK, the Government could simply opt to carry on selling gilts to the Bank of England, provided that the Bank agrees, which it is not bound to do. But even if it does, when it eventually raises Bank Rate, to normalise the economy and head off inflation, this would increase the Government’s funding costs.
And the supply of bank reserves, as well as broad money, would continue to expand rapidly, thereby increasing the inflationary danger. The way to stop this would be for the Bank to sell gilts to the market, i.e. reversing QE. But this would drive up their yields, and thereby increase the Government’s funding costs. So, when the authorities wish to deploy policies to stop inflation, the real cost of the current largesse will start to become clear. The chickens will then come home to roost.
It would be nice to believe that somehow such nasty trade-offs can be avoided. They can be postponed and they can be finessed at the margin through good policy and careful management. But in the end they will come back to bite us.
So I expect the OBR to give an assessment tomorrow that implicitly lends support to the Government’s strategy but that also issues a warning. In my view, it will be right on both counts.
Rishi Sunak, the Chancellor, meets an employee during a visit to the Worcester Bosch factory in the West Midlands